Volcker Rule Made Meaningless by Abundant Exemptions

Posted on Dec 18, 2013

By Nomi Prins

The subject of heated debate in financial circles, the Volcker Rule, which was originally passed as part of the 2010 Dodd–Frank Wall Street Reform and Consumer Protection Act, was finally approved by regulators. It will begin taking effect in April 2014 with full compliance required by July 2015. They say the devil is in the details. Regarding the Volcker Rule, the devil is in the details of its abundant exemptions. These include a laundry list of practices and businesses that mega-banks have performed under one roof, since the 1999 repeal of Glass-Steagall, as well as the myriad perks they won along the way to that power-consolidating event.

The Volcker Rule in its current form ostensibly focuses on mitigating the “excessive” risk of proprietary trading at banks (which it doesn’t do well). Worse, it leaves all the other risky trading related activity that poses a far greater systemic threat untouched, such as:

1) Market making—the ability of banks to trade on behalf of clients or eventual clients, which is how they make the bulk of their trading profits, and thus create risk.

2) Underwriting—the creation of securities that can contain multiple layers of financial complexity, such as the toxic assets at the heart of the recent crisis.

3) Hedging—or the desire of banks to “protect” themselves through trading, which is virtually impossible to detect from any other kind of trading.

4) Trading government bonds.

5) Organizing or offering hedge and private equity funds, which involves trading and was theoretically to be prohibited under the original intent of the Volcker Rule.

Other exclusions (yes, there are more) relate to the ability of banks to trade—proprietary or otherwise—within their brokerage arms (which are supposedly, but not actually, distinct from their deposit-taking arms) and insurance company arms (which have historically been eager buyers and accumulators of toxic assets).

The real danger of the Volcker Rule, though, isn’t just that it leaves the structure of Wall Street’s deposit-insured, security-distributing and market-making services intact. The danger is that Wall Street critics believe it makes a meaningful difference, that it’s an obvious road on the way to the Glass-Steagall reinstatement highway, and are thus not ranting and raving for it to be made stronger, even as the bank lobbyists and lawyers are making every effort to further weaken it.

The Volcker Rule Exclusions Are the Rule

Between effectiveness and legalese, you can drive an 18-wheeler of financial wizardry. And that’s even accepting the notion that proprietary trading was a key culprit in causing any major financial crisis, relative to nearly any other risk producing bank practice, which it wasn’t.

Even so, the banks have been lobbying for exemptions in this minimal attempt at regulation and won’t stop. Thus the eventual implemented rule will entail more pages of exemptions, particularly if the public remains oblivious to its current impotence to deter risk.

The Big Six banks (JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley) that control the majority of domestic deposits (and nearly all of U.S. derivatives) dangle them as financial hostages before complicit regulators, legislators and presidents. Too big to fail is about power, not size. These banks that sit atop the U.S. financial hierarchy by virtue of their legacy leaders having attacked 1933 Glass-Steagall regulations since the 1950s—piece by piece—own insurance companies, asset management companies, and brokerage or trading houses. They not only have access to an increasingly higher proportion of deposits, but also of pension and other funds, and insurance policies. That’s why one of the main things that banks did to weaken the possibility of broad restriction on any of their overall trading activities was to ensure these side financial service businesses would bear no restriction on trading, proprietary or otherwise, as per their exemptions in the Volcker Rule.

The Fed’s Language Game

The Volcker Rule won’t take full effect until July 15, 2015. Thus, the only thing that really happened on Dec. 10, 2013, was that the Fed announced that five federal agencies “issued final rules” to “implement section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the ‘Volcker Rule’).”

As Fed Chairman Ben Bernanke remarked with great fanfare from a media hailing the mere “adoption of final rules” as a deterrent to Wall Street’s most heinous behavior (December is a slow news month):

“This provision of the Dodd-Frank Act has the important objective of limiting excessive risk taking by depository institutions and their affiliates. Getting to this vote has taken longer than we would have liked, but five agencies have had to work together to grapple with a large number of difficult issues and respond to extensive public comments” (italics mine).

It’s true that the Volcker Rule has the ability to limit “excessive risk,” but only in the most literal sense. Even Bernanke’s choice of words indicated focus on a small portion of risk—not systemic risk and not the risk that these banks remain too powerful to fail.

A more misleading aspect of Bernanke’s statement was that he claimed it took so long to get to this point because of the need to address “public comments.” Given the comparative length of bank-supportive pages relative to public-protecting ones, “public comments” essentially means bank lobbyist demands.

Separately, the Fed’s press release underscored the elements of trading the rule would not touch as much, if not more so, than what it would. The release stated that insured-deposit-taking banks would be prohibited from “engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on those instruments for their own account” plus be subject to “limits on investments in, or relations with hedge funds or private equity funds.” But it also stated that “the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in government obligations, insurance company activities, and organizing and offering hedge funds or private equity funds.” In addition, it clarified that “certain activities are not prohibited.” That these exclusions were prominent in the Fed’s press release speaks volumes to the parties the Fed is trying to coddle.

For good political measure, under the Volcker Rule, each bank must establish a compliance program. CEOs must attest to the program’s integrity, under the eye of an outside regulator—who will have to take all this pious restraint at face value.

Breaking It Down

The proposed rules tally 892 pages, of which the beginning contains exposition and outlines the crux of the rule prohibiting certain proprietary trading and hedge and private equity fund activities.

The exclusions kick in on page 55. Through page 79, we get their general aspects, with more specific details following on page 80. We wander through Underwriting Exemptions from pages 80 to 139, followed by a long section on Market-Making Exemptions from pages 140 to 317.

Then, we get a bunch of permitted hedge fund related activities that nearly negate the idea of the Volcker Rule altering the relationship of big banks to big hedge funds from pages 317 to 361. From this point, we meander through permitted trading in certain government and municipal securities (including in foreign bonds). There are a few antiquated categories that seem open to more lobbying through page 388.

Permitted Trading on behalf of clients gets 10 pages, as does permitted trading by a regulated insurance company. Permitted trading activities of a foreign banking entity get 23 pages.

Then we come to a section that sounds sort of regulatory, but is too obtuse to tell from pages 433 to 447. After a few pages of definitions as to what constitutes “High-Risk Asset” and “High-Risk trading strategy,” we get one page—one page!—on trading that could “Pose a Threat to Safety and Soundness of the Banking Entity or the Financial Stability of the United States.”

Another section of loopholes begins with covered fund activities on page 463. This is the stuff that allows banks to trade almost anything anywhere as long as it’s named in such a way as to avoid suspicion. Section 10 begins with prohibitions on banks buying or having certain relationships with a “Covered Fund.”

Pages 500 to 637 provide lists of exemptions to the above such as foreign public funds, insurance company separate accounts, loan securitizations (which were central to the subprime crisis), derivatives on loan securitization (ditto), venture capital funds (another word for private equity funds) and credit funds (which can hold all sorts of AIG-type credit derivatives).

In Section 11, we get another laundry list of permitted activities in conjunction with organizing covered funds, including “permitted risk-mitigating hedging activities” (and aren’t they all?) from pages 638 to 766. These also include foreign funds and insurance companies. To cap it off, we get some obligatory legal jargon about how to comply with whatever weakened rules remain from pages 767 to 882. C’est tout.

Something Is Not Always Better Than Nothing

For those people who think the Volcker Rule is a swipe at the banks and will reduce risk in the system, I urge you to reconsider. The Volcker Rule (and Paul Volcker, for whom it’s named) might have had good intentions, but the form it has taken, and was destined to take as I’ve written before, is a placation. It is not substantive reform, or even the right path.

Only a resurrection of Glass-Steagall will truly reduce the risk mega-banks pose to our economic lives. The multiple decades of regulation assassination, the combining of financial services from insurance policies to our pension funds, the epic leverage in the banking system as part of the high-stakes game of global profit, the enabling of the derivatives market to reach many times the world’s GDP, disproportionally controlled by the Big Six U.S. banks—are all time bombs of financial devastation.

This immense power in the hands of the Big Six banks and their leaders is dangerous to all of us, whether we believe that something like the Volcker Rule or Dodd-Frank represents true reform or not. Without curtailing that power, through a full separation of deposits and loan taking services from any other kind of trading and security creation engine or other form of financial service—the intent of the original Glass-Steagall Act—we are not safe. There will be bigger and broader crises.

Our apathy is exactly what the banks, their CEOs, their lawyers and their lobbyists count on. They depend on citizens getting bored and glassy-eyed when a financial term is mentioned and turning to stories about Miley Cyrus twerking or Kim Kardashian’s bikini bod instead. They rely on journalists not reading between the lines or even tabulating the lines. They bet that most legislators (excluding Sens. Elizabeth Warren and Bernie Sanders) will focus anywhere else, because they can out-complicate the lingo. They are confident that the population will continue to furnish them chips on the global betting table. That is our current system. That is the system that must be abolished through the strict re-employment of Glass-Steagall. We—all of us—have too much at stake to be blindsided by anything else.